EU weighs direct aid to banks, Euro-bonds as crisis antidote

May 30 (Bloomberg) -- The European Commission called for direct euro-area aid for troubled banks, and touted a Europe- wide deposit-guarantee system and common bond issuance as antidotes to the debt crisis now threatening to overwhelm Spain.

The commission, the European Union’s central regulator, sided with Spain in proposing that the euro’s permanent bailout fund inject cash to banks instead of channeling the money via national governments. It also offered Spain extra time to squeeze the budget deficit.

The use of the rescue fund to recapitalize banks “might be envisaged” and would “sever the link between banks and the sovereigns,” the commission said today in Brussels. Jose Barroso, the commission’s president, said “it is important to use all possibilities offered in terms of flexibility.”

Proposals for more liberal use of European bailout money are likely to face resistance in creditor countries such as Germany, Finland and the Netherlands, the scenes of growing taxpayer opposition to more aid.

Signs of stress multiplied in financial markets today. Italy missed its target in a bond auction, driving its 10-year yields as high as 6.01 percent, the highest since Jan. 31. The yield was at 5.95 percent at 2:10 p.m. in Brussels. Doubts over the health of Spain’s banks pushed up Spanish 10-year yields as high as 6.70 percent, the highest since Nov. 28. That yield was last at 6.62 percent.

‘Exceptionally Tense’

After more than two crisis-filled years and 386 billion euros ($480 billion) in loan pledges to Greece, Ireland and Portugal, “markets remain exceptionally tense and vigilant and confidence is still weak,” the commission said.

The euro has tumbled 6 percent in May, hit first by concern that Greek voters will reject bailout conditions, then by worries that Spain will be forced to fall back on a European lifeline. The currency pared today’s decline after the commission floated the bank-recapitalization ideas. It last bought $1.2441.

Spain, the 17-nation euro area’s fourth-largest economy, is trying to simultaneously plug holes in regional budgets and detoxify its banks, all while struggling to lift the economy out of a recession.

Germany Leads Opponents

Current EU plans call for the 500 billion-euro European Stability Mechanism, set to start up in July, to funnel bank-aid money through national governments and, ultimately, require those governments to pay it back.

Germany is spearheading resistance to direct European financing for banks because that would let governments bypass the conditions set for full aid programs, such as deeper budget cuts and more European intrusion into economic management.

“Direct help for banks is out of the question, that won’t fly,” Norbert Barthle, the budget spokesman in parliament for Chancellor Angela Merkel’s Christian Democratic Union, said in an interview yesterday. Finland is in Germany’s camp, Martti Salmi, a Finance Ministry official, said in a telephone interview today.

The commission appealed for a “banking union” that would more tightly integrate supervision and create a pool of European funds to clean up banks with cross-border exposure and segregate their underperforming assets.

“It’s hard enough to bail out local banks let alone non- domestic banks,” said Harvinder Sian, a London-based fixed- income strategist at Royal Bank of Scotland Group Plc. “A crisis lesson so far is that big ideas coming from Brussels or the guys taking the money are noise up until the point that the Germans get on the same page.”